The Impact of Tax Incentives on Foreign Direct Investment in Ethiopia

Abstract

This study critically evaluates the efficiency and impact of tax incentives on attracting and retaining Foreign Direct Investment (FDI) in Ethiopia, addressing the central policy assumption that generous fiscal concessions, such as tax holidays and customs duty exemptions, constitute the primary mechanism for securing global investment capital. Given the potential cost to public revenue, this research was designed to provide empirical evidence on the cost-effectiveness and sustainability of the current incentive system. The methodology utilized a analysis of two decades of FDI flow data to establish macro-level correlations, which was then critically complemented by a comprehensive qualitative survey of over 28 foreign investors and senior management across key manufacturing and service sectors in Ethiopia. The survey specifically focused on ranking investment criteria, contrasting the perceived value of tax breaks versus the essential stability of the operating environment, infrastructure quality, and efficient bureaucratic processes. The findings conclusively reveal that while fiscal incentives successfully reduce entry barriers and secure initial commitments, their influence is quickly eclipsed by non-fiscal factors; long-term investment decisions, capital retention, and reinvestment are overwhelmingly driven by political predictability, minimized regulatory friction, and efficient access to Ethiopia's burgeoning domestic and regional markets. Crucially, the analysis identifies a systemic inefficiency where the current generalized incentive system, being largely untargeted and sector-agnostic, results in significant public revenue leakage without a corresponding proportional increase in high-quality, export-oriented FDI. Recommendation: Consequently, the paper concludes that the current policy is suboptimal for maximizing national development goals, advocating for a fundamental shift away from generalized tax holidays towards a strategic, performance-based incentive framework linked to measurable metrics like export volume and technology transfer, which must be immediately coupled with urgent policy action to enhance core institutional factors and infrastructural capacity to improve Ethiopia’s overall investment climate.